Significant Accounting Policies
|6 Months Ended|
Jun. 30, 2018
|Accounting Policies [Abstract]|
|SIGNIFICANT ACCOUNTING POLICIES||
2 — SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions for Form 10-Q and Article 8 of Regulation S-X. In the opinion of management, the accompanying unaudited condensed financial statements reflect all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation of such interim results. The interim operating results are not necessarily indicative of results that may be expected for any subsequent period. These unaudited condensed financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2017, included in the Rule 424(b)(4) Prospectus filed on July 30, 2018.
Liquidity and Uncertainties
The Company’s management has evaluated whether there are conditions or events, considered in the aggregate, that raise substantial doubt as to their ability to continue as a going concern for at least one year after the financial statements are issued. The Company continues to be in the pre-revenue development stage and is in the process of planning and executing a Phase 3 clinical trial. As of June 30, 2018, the Company had an accumulated deficit of approximately $2.6 million (net of reclassification of its accumulated deficit prior to reincorporation of approximately $10.7 million to Additional paid in capital on reincorporation), and has incurred net losses of approximately $2.2 million and $443,000 for the six months ended June 30, 2018 and fiscal year ended December 31, 2017, respectively, as well as annual losses since inception. Subsequent to quarter end the Company raised $6.3 million in an initial public offering (IPO), net of offering expenses. As of the financial statement issuance, the Company has cash on hand of approximately $5.0 million after repayment of obligations triggered by the IPO and other operating expenses. Based on the current development plans for AD04 in both the U.S. and foreign markets and the Company’s other operating requirements, the existing cash at the financial statement issue date will be sufficient to fund operations for at least the next twelve months following that date. However, it is not expected that the existing cash at the financial statement issue date will be sufficient to complete the planned Phase 3 clinical trial of AD04.
The Company’s ability to complete its ongoing research and development efforts and the planned Phase 3 clinical trial will depend on its ability to raise additional capital through equity and/or debt financings, strategic relationships, or out-licensing of its products. As the Company continues its research and development effort, it will pursue financing beyond the IPO. There are no assurances that such financings or strategic relationships will be available or, if available, successful. Without additional funding, management would be required to delay, scale back or eliminate some or all of its research and development which would likely have a material adverse effect on the Company.
Generally, the Company’s operations are also subject to a number of factors that can affect its operating results and financial condition. Such factors include, but are not limited to: the results of clinical testing and trial activities of the Company’s product candidates; the ability to obtain regulatory approval to market the Company’s products; the ability to manufacture the Company’s products successfully; competition from products manufactured and sold or being developed by other companies; the price of, and demand for, Company products; ability to negotiate favorable licensing or other manufacturing and marketing agreements for its products; as well as the aforementioned ability to raise capital during its development stage.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures. On an ongoing basis, management evaluates its estimates, including estimates related to but not limited to, share based compensation, derivative liabilities, fair value measurements, intangible assets useful life, and contingent liabilities. The Company bases its estimates on historical experience and other market specific assumptions that it believes to be reasonable under the circumstances. Accounting estimates used in the preparation of these financial statements may change as new events occur, as more experience is acquired, or as additional information is obtained. Actual results could differ from those estimates.
Basic and Diluted Earnings (Loss) per Share
Basic and diluted earnings (loss) per share are computed based on the weighted-average outstanding shares of stock, which are all voting shares. For purposes of these statements, the conversion of units into common shares associated with the reorganization of ADial Pharmaceuticals, LLC into Adial Pharmaceuticals, Inc (see Note 8) on October 1, 2017 has been retroactively reflected for all periods presented.
Diluted net loss per share includes the potential dilutive effect of common stock equivalents as if such securities were converted or exercised during the period, when the effect is dilutive. Common stock equivalents include outstanding warrants and options which are included under the “treasury stock method” when dilutive and common stock to be issued upon the assumed conversion of outstanding convertible notes, which are included under the “if converted method” when dilutive. Warrants to purchase approximately 782,555 common shares, shares to be issued upon exercise of 174,282 options outstanding, and 162,500 shares to be issued on voluntary conversion of the June 2018 Senior Note were all excluded from the computation of diluted earnings (loss) per share for the six months ended June 30, 2018 and 2017, because their effect on the loss per share is anti-dilutive.
The Company recently completed an IPO of 1,464,000 units consisting of a share of common stock and a warrant to purchase a share of common stock for $6.25 (“Units”), at an offering price of $5 per unit was completed after quarter end. Existing agreements required the issuance of additional units, warrants to purchase units (“Unit Warrants”), and warrants to purchase shares of common stock (“Warrants”) upon the IPO being consummated. The total number of common shares and share equivalents issued related to such agreements outstanding at July 31, 2018, the date of the closing of the IPO, were as follows:
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. At times, the Company’s cash balances may exceed the current insured amounts under the Federal Deposit Insurance Corporation. There were no accounts that exceeded federally insured limits at June 30, 2018 or December 31, 2017.
Intangible assets consist primarily of the trademarks and copyrights. The trademarks and copyrights are being amortized using the straight-line method based on an estimated useful life of 20 years.
Impairment of Long-Lived Assets
The Company’s long-lived assets (consisting of the trademarks) are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the undiscounted future net cash flows expected to be generated by that asset. If the carrying amount of an asset exceeds its estimated future undiscounted cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset.
Research and Development
Research and development costs are charged to expense as incurred. Research and development expenses include, but are not limited to, employee-related expenses including salaries, benefits and stock based compensation of research and development personnel, fees associated with consultants supporting our research and development endeavors, expenses incurred under agreements with contract research organizations and costs associated with pre-clinical activities. These costs are charged to operations as incurred as research and development expense.
Embedded Derivative Liability — Convertible Notes
The Company had convertible notes outstanding at June 30, 2018 and December 31, 2017 with a default payment provision (a default provision that requires payment of three times the outstanding principal amount plus accrued interest). The Company determined that the default provision is an embedded component that qualifies as a derivative which should be bifurcated from the convertible notes and separately accounted for in accordance with FASB ASC 815, “Derivatives and Hedging”. ASC 815 – 15 – 25 – 42 establishes criteria to determine whether puts are closely and clearly related to a debt host should the debt contain a substantial premium or default provision (one that is greater than 10% of the principal resulting from puts that require payoff for more than 110% of principal amount outstanding). The embedded derivative was recorded at fair value on the date of issuance and marked-to-market at each balance sheet date with the change in the fair value recorded as income or expense in the statement of operations (see Note 5).
The Company issued equity options to certain employees. Prior to reincorporation, these options were for the purchase of Class A equity units. All options for the purchase of shares of Class A units outstanding at the time of reincorporation were converted to options for the purchase of shares of common stock, in the same proportion as that used to convert Class A units to shares of common stock (see Note 8). Options are accounted for under FASB ASC 718 “Compensation — Stock Compensation” (“ASC 718”).
The Company measures the cost of awards based on the grant date fair value of the awards. That cost is recognized on a straight-line basis over the period during which the employee was required to provide service in exchange for the entire award. The fair value is calculated using the Black-Scholes option pricing model, based on key assumptions such as the fair value of shares of common stock or Class A units, expected volatility, and expected term. The Company’s estimates of these assumptions are primarily based on third-party valuations, historical data, peer company data and the judgment of management regarding future trends.
The Company accounts for equity-based compensation issued to non-employees and consultants in accordance with the provisions of FASB ASC 505-50 “Equity – Based Payments to Non-employees”. The non-cash charge to operations for non-employee awards with time based vesting provisions is based on the fair value of the awards re-measured each reporting period and amortized to expense over the remaining vesting period.
The Company was reorganized as a C corporation in 2017. Prior to reorganization, for federal and state income tax purposes, the Company was a limited liability company treated as a partnership, in which income tax liabilities and/or benefits were passed through to the Company’s unitholders. As such, the Company did not directly pay federal and state income taxes and recognition was not given to federal and state income taxes for the operations of the Company prior to reorganization.
Effective on completion of the LLC conversion on October 1, 2017, the Company accounts for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and tax carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Fair Value of Financial Instruments and Fair Value Measurements
FASB Accounting Standards Codification (“ASC”) Topic 820, “Fair Value Measurements and Disclosures,” requires disclosure of the fair value of financial instruments held by the Company. ASC Topic 825, “Financial Instruments,” defines fair value, and establishes a three-level valuation hierarchy for disclosures of fair value measurement that enhances disclosure requirements for fair value measures. The carrying amounts reported in the balance sheets for current liabilities, convertible notes, Senior Notes, Senior Secured Bridge Notes, and Subordinated Notes are a reasonable estimate of their fair values because of the short period of time between the origination of such instruments and their expected realization and their current market rate of interest. The carrying value of all other financial liabilities at cost approximates fair value.
The three levels of valuation hierarchy are defined as follows:
Recent Accounting Pronouncements
Leases — In February 2016, the FASB issued ASU 2016-02 which amends existing lease accounting guidance, and requires recognition of most lease arrangements on the balance sheet. The adoption of this standard will result in the Company recognizing a right-of-use asset representing its rights to use the underlying asset for the lease term with an offsetting lease liability. ASU 2016-02 will be effective for fiscal years beginning after December 15, 2018. In July 2018, the FASB issued ASU 2018-10, “Codification Improvements to Topic 842, Leases.” The amendments in ASU 2018-10 affect narrow aspects of the guidance issued in ASU 2016-02. The Company is currently evaluating the potential impact of the adoption of this accounting pronouncement to its financial statements.
Earnings per Share, Distinguishing Liabilities from Equity, and Derivatives and Hedging — In July 2017, the FASB issued ASU 2017-11, "Earnings Per Share (Topic 260) Distinguishing Liabilities from Equity (Topic 480) Derivatives and Hedging (Topic 815)," which addresses the complexity of accounting for certain financial instruments with down round features. Down round features are features of certain equity-linked instruments (or embedded features) that result in the strike price being reduced on the basis of the pricing of future equity offerings. Current accounting guidance creates cost and complexity for entities that issue financial instruments (such as warrants and convertible instruments) with down round features that require fair value measurement of the entire instrument or conversion option. The amendments in Part I of this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018 with early adoption permitted. The Company early adopted ASU 2017-11 at the beginning of the second quarter of 2018; there was no effect on the financial statements at the time of adoption.
Fair Value — In June 2018, the FASB issued ASU No. 2018-07, Compensation-Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting (“ASU 2018-07”). ASU 2018-07 amends the FASB Accounting Standards Codification (“ASC”) to expand the scope of FASB ASC Topic 718, Compensation-Stock Compensation, to include accounting for share-based payment transactions for acquiring goods and services from non-employees. The amendments in ASU 2018-07 are effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the impact of adopting this guidance.
The entire disclosure for all significant accounting policies of the reporting entity.
Reference 1: http://fasb.org/us-gaap/role/ref/legacyRef